Dust flux, Vostok ice core

Dust flux, Vostok ice core
Two dimensional phase space reconstruction of dust flux from the Vostok core over the period 186-4 ka using the time derivative method. Dust flux on the x-axis, rate of change is on the y-axis. From Gipp (2001).

Tuesday, November 5, 2013

Happy anniversary chaos!

Fifty years ago, Edward Lorenz published the first paper (pdf) generally recognized to discuss chaos.

Lorenz didn't call what he had discovered 'chaos'. It's not clear that he really understood the importance of what he had discovered. He knew it was interesting, and when scientists find something interesting they publish it, and worry about the ramifications later.

What Lorenz had discovered is that a deterministic system could have unpredictability. It is difficult to convey how unexpected this discovery was at the time, because the idea of what is now called chaos has disseminated (although imperfectly) through our common culture. A deterministic system is one in which the rules are well described (via equations) which operate on data to produce results. Since the time of Laplace's Dr. Manhattan quote, it had always been assumed that nothing unexpected could arise from such a system when an initial position and the rules of motion were defined to arbitrary precision. Unexpected behaviour should only result from randomness.

So when Lorenz put together a simple model for atmospheric convection in the presence of heating, he used three simple differential equations, simple boundary conditions, and an arbitrary starting point, there would have been no reason to suspect that anything unexpected might occur. After all, all the parameters in the equations were known.

In essence, what he discovered was that minute variances in starting conditions led to extremely large variations in outcome. This again was unexpected, because our knowledge was largely built on assumptions of linear behaviour, in which small variations only grow larger slowly. Lorenz's interpretation of what he had discovered was to correctly point out that long-term weather forecasting was impossible, because it was impossible to measure the present state of the system with perfect accuracy--and the range of possible differing outcomes from the measurement accuracy was essentially the range of all possible weather.

The discovery and formalization of chaos theory led to entirely new fields of study encompassing different aspects of nonlinear dynamics and complex systems. Among them is one field of endeavour which has been a point of interest on this blog--complexity.

What do we mean by complexity? Actually, I'll write about this in a future posting. For now, let's just note the relative unpredictability of complex systems and get into the whys of it all later.

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This post is a bit belated, because Lorenz's publication was actually in March. But something as momentous as chaos should celebrate over the course of an entire year.

Sometimes we go all out and celebrate something over a couple of years. International Geophysical Year (1957-58) and International Heliophysical Year (2007-08) come to mind.

There have already been numerous celebratory events so far this year. But first, a word about the enablers of this year's celebrations on the markets.

High-frequency trading spams the exchanges with empty quotes destined to be cancelled--so much that it appears that many legitimate offers do not get filled at optimum pricing, as the system becomes overwhelmed with meaningless numbers.

According to the exchanges, HFT is a good thing. It increases liquidity, or at least that is the axiom that guides their acceptance. Unfortunately, observation tells us that the opposite may be the case--that HFT causes liquidity to vanish precisely at the time it is most needed.

In the last 50 years, we entered the nonlinear world. But our thinking--especially institutional thinking--is still trapped in the linear world.

In the linear world, if something is a benefit, then more of it is a greater a benefit. But in the nonlinear world, where one may be a benefit, and two may be better; three could turn out to be horrifying.

So in celebrating 50 years of chaos, the exchanges (with their sponsors, the algos) have brought you the following celebratory events.

Flash crash on the German market. Twitter feed flash crash. (Appropriately enough, both of these were in April). Thee Anadarko flash crash. Information travels faster than the speed of light! Closing of the Nasdaq options bourse. Not to mention hundreds of strange trade executions across all the exchanges.

How to lose lots of money in 45 ms by Nanex.

Most of these problems are the (un)predictable result of the interaction of numerous algorithms. Some may have been errors, or the so-called 'fat finger' trades; others may have been other form of human or algo error.

Algo error. Was that supposed to happen?

The markets are not what they used to be. The overall superstate has changed over the last ten years from one dominated by humans to one dominated by machines. The result has a been a series of entirely new phenomena, which we have earlier termed 'innovation'.

The year isn't over yet. I look forward to the next special event. I don't think I have long to wait.

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And then there's this. I was going to put in something by King Crimson here, but this seemed more appropriate.

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